The Winners And Losers In Chinese Capitalism

The most popular recurring foreign talking point on China's surging economy in the era of the global financial crisis is something like, "Maybe they have got something figured out over there in Beijing that we don't." That is, maybe authoritarian state-led capitalism isn't all that bad.

Well, I can agree that state capitalism is certainly not bad for the winners, China's state-owned enterprises. But what about the losers? I am thinking now of some people you might not normally have sympathy for, China's rich (or once-rich) private entrepreneurs. Over the years I have encountered peasant oil barons, coal mine bosses, private airline chiefs and real estate developers who have all learned to rue the defects of state capitalism. Their stories differ widely but most have the same ending: profitable assets ended up in the hands of the government, and private risk-takers lost.

The New York Times weighed in yesterday on this discussion (see "China Fortifies State Businesses to Fuel Growth"), as have two of our Forbes China Tracker contributors (see here and here). Whether or not the so-called China model deserves praise, grumbling about favoritism for the state sector has been percolating within China for many years, and it has become far more urgent in the last 18 months as the economy recovered and thrived on state-led investment and lending. The phenomenon is known in Chinese as "guo jin, min tui," or "the state advances, the private sector retreats," and entrepreneurs may utter the phrase as the forlorn coda to tales of fortunes lost or never won.

The travails of China's private capitalists have fascinated me since I came across, in 2004 with The Baltimore Sun, the curious case of private oil wells seized by the government in northwest China's Shaanxi Province (See "For Chinese peasants, an oil boom goes bust"). Tens of thousands of farmers in a historically poor, undeveloped region had invested their family savings in thousands of oil wells in a rare example of the government allowing private drilling.

It was a complex tale as different levels of government squabbled over the privately gained spoils -- Beijing ordered local officials to re-nationalize the wells in cooperation with the country's largest oil producer, China National Petroleum Corp. (its listed arm is known as PetroChina). But one result was certain: the peasants wouldn't be keeping the spoils. "Before oil was only making a small number of people rich," was how the official news service Xinhua spinned it in 2004. "Now, oil is bringing wealth to all the people."

It is funny the number of ways in which profits can be transferred from "a small number of people" (private entrepreneurs) to "all the people" (the state). The Internet is one of the biggest exceptions where private businesses flourish, but even there, when companies like Tencent started making big money off of mobile-related services, the big state carriers, China Mobile and China Unicom, had the duopoly power to claw back much of that rich revenue stream. When private coal mine bosses became infamously wealthy off of one of the deadliest industries in the world, the government forced private mines to close or be folded into state-owned giants, ostensibly in the name of safety (see my story "Black Future").

When entrepreneurs gambled on starting private airlines, already a tough gambit anywhere, they struggled to contend with state economy favoritism at every turn, on financing for planes, on scheduling and routes, on fueling their planes, on the hiring of pilots. Spring Airlines founder and CEO Wang Zhenghua told me last year that in 2008, he had to pay state-owned airlines a total of 100 million RMB (nearly $15 million) to hire 30 flight captains: "Some captains cost us 4 million yuan. It's like throwing this 4 million yuan into the water," he said. "SOEs, they don't like us to grab their captains. We don't want relations with SOEs to be so sour." (See "SOEs Aloft").

Indeed, the best way to stay alive as a private entrepreneur in an industry the state dominates — and there are many of those — is to stay small. "Our principle is that we don’t make trouble for the SOEs, and they don’t consider us competition,” Wang Junjin, chairman of JuneYao Airlines, told me. “Don’t do the things they don’t like. Don’t make them think you’re going to squeeze them out of the market. You cannot step on others to climb up.” Not exactly the capitalist credo you might pick up in business school.

In any case, it is difficult to expand without financing, and Chinese state capitalism is terrible at lending to private businesses. This was glaringly true during the financial crisis: While state banks made headlines globally for their gigantic lending spree to mostly state-owned enterprises, thousands of private companies faced bankruptcy, desperate for underground loans at high interest rates (see "Chinese Credit" for more on where such companies turn for cash). Bank of China Chairman Xiao Gang explained the warped but very rational incentive system that drives bank lending in his commentary last week, "Don't blame it on the government," writing:

While expanding their loan portfolios, Chinese banks are smart enough to take the risk-averse approach and to focus on lending to large State-owned enterprises (SOEs). These SOEs often enjoy monopoly in their sectors and favorable conditions in an industry and enjoy quasi-government credit ratings.

In other words, banks figure the large SOEs won't go bankrupt and default on their loans. It is not so much that they are too big to fail. They are too government to fail. That was one reason why the president of a third struggling private airline, Okay Airways, told me, "The SOEs laugh at us, 'Yeah, we're the government's companies, of course the government will help us'."

I note all this not to indict the Chinese financial system, or any one model — we all know the U.S. financial system struggles with its own problems. The policymakers of Beijing have leaned hard on their system to turbocharge the economy during a global slowdown, and it has worked so far.

But the question I have is one that has been posed intelligently by others before me including Huang Yasheng, author of an essential book for understanding China's hybrid economy, "Capitalism With Chinese Characteristics." That question is, could the Chinese economy be doing even better, if the government did more to help private entrepreneurs succeed rather than fail?

I've been Beijing bureau chief for Forbes since 2007, writing about insider trading, art market manipulation, corrupt journalists, brave lawyers, the Google kerfuffle, what Tencent has figured out that Facebook hasn't, and awful books on doing business in China. I have also ...